SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 39520 / January 7, 1998
Admin. Proc. File No. 3-9192
:
In the Matter of the Applications of :
:
EQUITY SECURITIES TRADING CO., INC. :
2820 IDS Center :
80 South 8th Street :
Minneapolis, MN 55402 :
:
NATHAN NEWMAN :
2110 Austrian Pine Line :
Minnetonka, MN 55305 :
:
and :
:
LAURENCE STUART ZIPKIN :
2801 Westridge Road :
Minnetonka, MN 55305 :
:
For Review of Disciplinary Action Taken by the :
:
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. :
:
OPINION OF THE COMMISSION
REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY
PROCEEDINGS
Violations of Rules of Fair Practice
Failure to Comply with Free-Riding and Withholding
Interpretation
Failure to Supervise
Registered representatives sold shares of "hot issues" in
contravention of association's Free-Riding and Withholding
Interpretation. Member firm of registered securities association
and its president failed reasonably to supervise all but one of
these transactions. Held, association's disciplinary action
sustained in part and reversed in part.
APPEARANCES:
Matthew D. Wayne and Robert A. Vanasco, of Fishman & Merrick, P.C.,
for Equity Securities Trading Co., Inc., Nathan Newman, and Laurence Stuart
Zipkin.
Alden S. Adkins and Susan L. Beesley, for NASD Regulation, Inc.
Appeal filed: November 13, 1996
Briefing completed: March 5, 1997
I.
Equity Securities Trading Co., Inc. ("Equity" or the "Firm"), a member
firm of the National Association of Securities Dealers, Inc. ("NASD");
Nathan Newman, Equity's president and a registered general securities
principal, financial and operations principal, and options principal; and
Laurence Stuart Zipkin, a sales representative with Equity and a registered
general securities representative (collectively "Applicants"), appeal from
NASD disciplinary action. The NASD found that Zipkin violated Article III,
Section 1 of the NASD's Rules of Fair Practice ("Rules") when, in
contravention of the NASD's Free-Riding and Withholding Interpretation (the
"Interpretation"), he sold "hot issues" to broker-dealers and associated
persons of broker-dealers. The NASD also found that Equity, acting through
Newman, failed to supervise properly and adequately Zipkin's sales, as well
as a sale of a "hot issue" by another Firm registered representative, in
violation of Article III, Sections 1 and 27 of the Rules.
The NASD censured each Applicant, fined Equity and Newman $7,500
jointly and severally, and fined Zipkin $2,500. Our findings
are based on an independent review of the record.
II.
The NASD recently revised and renumbered its Rules, but
no substantive changes were made to the particular
rules at issue here. Article III, Section 1 of the
Rules [new Conduct Rule 2110] requires that members, in
the conduct of their business, observe high standards
of commercial honor and just and equitable principles
of trade. The Interpretation [new IM-2110-1] requires
members to make a bona fide public distribution of
securities of a public offering that trade at a premium
in the secondary market whenever such secondary market
begins. Article III, Section 27 [new Conduct Rule
3010] requires a member to establish, maintain, and
enforce a supervisory system with written procedures.
The NASD also assessed costs against Applicants,
jointly and severally.
======END OF PAGE 2======
======END OF PAGE 3======
A. The Applicants admit that, on February 22, 1993, April 5, 1993,
and October 27, 1993, Zipkin sold the securities of Gaming Corporation of
America, Casino Data Systems, and Acres Gaming Incorporated in twenty-two
transactions to a total of thirteen customers. Each of these offerings was
a "hot issue," that is, a security issued in a public offering that began
trading in the after-market at a substantial premium. On the
applicable transaction date, each customer was a member of and a "local
trader" on the Chicago Board Options Exchange, Inc. ("CBOE"). Each
customer was also registered as, or associated with, a broker-dealer. None
of the broker-dealers was a member of the NASD. Zipkin knew that each
customer was a CBOE member at the time Zipkin opened the customer's account
at Equity although he testified that he was not aware that each customer
was or associated with a broker-dealer.
The Interpretation requires NASD members to make a bona fide public
distribution of hot issues. This obligation is designed to prevent the
restriction of the supply of a hot issue by withholding shares from the
market and forcing public customers who want to purchase that hot issue to
acquire it in the aftermarket at a higher price. In furtherance
of this requirement to make a public market, the Interpretation generally
prohibits the sale of hot issues to any broker-dealer or any person
associated with a broker-dealer.
The February 22, 1993 offering of Gaming Corporation of
America, for which Equity was an underwriter, was
priced at $6.75 per unit and at the opening of the
secondary market sold for an immediate aftermarket
premium at $10.75 per unit. The April 5, 1993 offering
of Casino Data Systems, for which Equity was an
underwriter, was priced at $5.00 per share and at the
opening of the secondary market sold for an immediate
aftermarket premium at $7.00 per share. The October
27, 1993 offering of Acres Gaming Incorporated, for
which Equity was a member of the selling group, was
priced at $5.00 per unit and at the opening of the
secondary market sold for an immediate aftermarket
premium at $10.00 per unit.
First Philadelphia Corp., 50 S.E.C. 360, 361 (1990).
Specifically, the Interpretation precludes selling hot
issues:
to any officer, director, general partner, employee or
agent of the member or of any other broker/dealer, or
to a person associated with the member or with any
other broker/dealer, or to a member of the immediate
family of any such person . . . [or] to any
broker/dealer
(continued...)
======END OF PAGE 4======
While Applicants agree that Zipkin's transactions may fall within the
literal language of the Interpretation, they suggest a variety of reasons
why the Interpretation should not be applied to these transactions.
Applicants argue that the fact that the CBOE local traders are registered
as broker-dealers is "merely technical." They assert that these particular
CBOE local traders "trade on the floor . . . with their own capital, for
their own accounts and have no retail transactions." Section 3(a)(5) of
the Securities Exchange Act of 1934 ("Exchange Act") defines the term
"dealer" as "any person engaged in the business of buying and selling
securities for his own account, through a broker or otherwise, . . . as
part of a regular business." Section 3(a)(10) of the Exchange Act further
defines a "security" to include "any put, call, straddle, option, or
privilege on any security." Thus, persons, such as CBOE members, who trade
as part of a regular business in securities, are required to register as
broker-dealers.
Applicants also assert that Zipkin's sales to CBOE local traders did
not violate the "purpose and intent" of the Interpretation. They claim
that "there is absolutely no business that these individuals ever referred
or can ever refer to Equity or any other member firm."
Under fundamental principles of construction, there is no need to
refer to the purpose or intent of a rule when the rule is unambiguous.
The language of the Interpretation is not ambiguous. It
(...continued)
unless that broker-dealer gives written assurance that the
purchases are to fill orders for bona fide public customers.
Applicants also assert that the CBOE local traders
engage in transactions that are equivalent to
transactions on the Chicago Mercantile Exchange
("CME"). They claim that an NASD member would not be
prohibited from selling a hot issue to a CME member.
The CME is not a national securities exchange, but
rather a contract market designated pursuant to the
Commodity Exchange Act. Assuming arguendo that the
instruments traded by the CME may in certain instances
be economically similar to those traded by the CBOE,
the fact remains that the CME does not trade in
securities as defined in Section 3(a)(10) of the
Exchange Act. Thus, a CME member that restricts its
activity to instruments that are not securities is not
required to register as a broker-dealer. Of course, if
the particular CME member engaged in securities
transactions that required registration as a broker-
dealer, the Interpretation would apply.
Cf. Natural Resources Defense Council, Inc. v. Browner,
57 F.3d 1122, 1127 (D.C. Cir. 1995) ("[w]here the terms
(continued...)
======END OF PAGE 5======
plainly prohibits selling hot issues both to a broker-dealer or any
associated person thereof.
Moreover, we disagree that these or similar transactions could not
violate the purpose of the Interpretation. As discussed above, one of the
purposes of the Interpretation is to prevent broker-dealers from
withholding a hot issue until the aftermarket, forcing public customers to
pay more in the secondary market for that issue. We are not suggesting
that the record before us indicates that the CBOE members purchased these
hot issues for a purpose prohibited by the Interpretation. However,
failure to comply with the Interpretation does not require such a showing.
Moreover, the record before us does not demonstrate why transactions by
registered broker-dealers who are also CBOE local traders would never
result in improper withholding of a hot issue from public customers.
We also reject Applicants' argument that Zipkin should not be
sanctioned because his conduct was merely a "technical" violation of the
Interpretation. They assert that Zipkin did not know, nor could he have
known, that CBOE local-traders were registered broker-dealers. In
determining whether the Interpretation was violated, it is irrelevant that
the violation was technical or inadvertent. As we have previously stated,
the Interpretation does not require scienter to support a finding of
violation. Moreover, if any of the Applicants had checked the
Central Registration Depository ("CRD") or reviewed the requirements of the
Exchange Act, the fact that these CBOE local traders were registered as, or
associated with, a broker-dealer would have been apparent.
(...continued)
of a statute are unambiguous, further judicial inquiry
into the intent of the drafters is generally
unnecessary").
We have previously made clear that persons associated
with an NASD member are obligated to be familiar with
and comply with the Rules such as the Interpretation.
See, e.g., Gilbert M. Hair, 51 S.E.C. 374, 378 n.12
(1993) (an associated person has a duty to be aware of
and comply with applicable agency rules and
regulations).
First Philadelphia Corp., 50 S.E.C. at 361.
As a precondition of membership and in accordance with
the Securities Exchange Act of 1934, the CBOE requires
its members to register with this Commission as, or
associate with, a broker or dealer. See CBOE Rule 3.2
("Individual memberships may be owned by a natural
person who . . . is registered as a broker or dealer
pursuant to Section 15 of the Securities Exchange Act
of 1934, as amended, or is associated with a registered
broker or dealer . . . .")
======END OF PAGE 6======
Applicants request that we direct the NASD to modify or amend the
Interpretation to exclude transactions in hot issues with CBOE local
traders. The Exchange Act provides specific procedures for review of self-
regulatory organization rules, such as the Interpretation.
The NASD has in the past considered and modified the Interpretation -- the
most recent amendment becoming effective in August 1996. In each instance,
however, the proposed modification or amendment was submitted to this
Commission and published for public comment before we approved the change,
as required by the Exchange Act. We believe this procedure permits the
consideration of potential concerns and the impact of a proposed
modification on the securities market place and its participants.
For these reasons, we find that Zipkin violated the Interpretation,
and thereby Article III, Section 1 of the Rules, when he sold hot issues to
Equity customers who were registered as, or associated with, broker-
dealers.
B. We also agree with the NASD's finding that Equity and Newman
failed to supervise Zipkin properly and adequately with respect to Zipkin's
sales of hot issues to CBOE members. Newman, who had supervisory authority
over all of Equity's operations, reviewed all accounts for hot issue
restrictions. Newman also knew that these particular customers were CBOE
members at the time Zipkin opened accounts for the customers at Equity.
Newman failed to recognize that the customers were broker-dealers or
associated persons and failed to prevent these customers from purchasing
hot issues. Therefore, we find that Equity, acting through
Newman, and Newman violated Article III, Sections 1 and 27, by failing to
supervise Zipkin and permitting the execution of trades in hot issues that
were prohibited by the Interpretation.
Compare Exchange Act Section 19(e)(1)(A) and Exchange
Act Sections 19(b) and 19(c).
Applicants argue that the Interpretation predates the
formation of the CBOE by three years and suggest that
the Interpretation did not properly consider the role
of CBOE local traders. However, as discussed above,
the NASD has amended the Interpretation from time to
time since both the Interpretation's and the CBOE's
inception.
We also note that Applicants petitioned the NASD to modify
the Interpretation after Zipkin executed the contested
transactions, but before the NASD initiated this proceeding.
The NASD rejected Applicants' petition.
As with the allegations against Zipkin, we reject
Newman's contention that he did not know, nor should he
have known, that the CBOE members were registered
broker-dealers.
======END OF PAGE 7======
III.
Michael J. O'Brien was a registered representative at Equity. In
March 1992, O'Brien opened an account at Equity in the name of Stillwater
Junior Scholarship Fund (the "Scholarship Fund"). O'Brien gave as the
address and telephone number of the Scholarship Fund his home address and
both his home and business telephone numbers. However, he submitted a
separate tax identification number for the Scholarship Fund. He also
provided the Firm with the Scholarship Fund's by-laws, dated 1983. The by-
laws stated that the Scholarship Fund had been created by the members of
the Stillwater Country Club and had as its purpose the granting of
"scholarships for post-high school educational opportunities to qualified
students." O'Brien also tendered a resolution from the Scholarship Fund
that authorized O'Brien and a third party to effect securities transactions
on behalf of the Scholarship Fund.
Newman, on behalf of Equity, approved opening the Scholarship Fund
account. He was aware at the time that the Scholarship Fund's address and
telephone numbers belonged to O'Brien. He asked O'Brien whether O'Brien
had any beneficial interest in the Scholarship Fund, and O'Brien denied it.
Newman testified that the cashier would not have questioned a deposit by
O'Brien into the Scholarship Fund because O'Brien was an officer of the
fund. At the time, the Firm did not review endorsements on checks issued
from a customer account.
In September 1992, O'Brien deposited an $8,000 cashier's check, which
identified O'Brien as the remitter, in the Scholarship Fund account. The
source of these funds was in fact a bank loan to O'Brien although that
information did not appear on the face of the cashier's check. Thereafter,
he caused the account to issue 16 checks of $500 each to various colleges
and universities for the benefit of 16 separate individuals.
During 1993, Newman placed O'Brien on "heightened" supervision although the
record does not indicate the nature of that supervision or its cause. In
the winter of 1993, O'Brien deposited two additional checks into the
Scholarship Fund, for $500 each. After each deposit, an additional
scholarship check for $500 was issued from the account.
On or about April 23, 1993, the Scholarship Fund account purchased
5,000 shares of Developed Technology Resources, Inc. ("DTR"). DTR was a
hot issue. On May 7, 1993, O'Brien deposited his personal check for
$25,000 into the account. Thereafter, O'Brien deposited his own funds into
the Scholarship Fund account with greater frequency, and withdrew a total
of $40,448.18 in the form of eight checks. The eight checks were made
payable to the Scholarship Fund and subsequently endorsed by O'Brien. It
The checks, which are in the record, contain the
endorsement of the college or university and, in some
instances, of the individual recipient. There were
checks made payable to at least 13 separate post-
secondary institutions. None of the individuals had
the last name "O'Brien."
======END OF PAGE 8======
is not alleged that the Scholarship Fund engaged in any further
transactions in hot issues.
The NASD found that the Scholarship Fund account was beneficially
owned by O'Brien because he "repaid" himself "loans" made to the account.
The NASD held that Newman had sufficient red flags that
O'Brien owned the account. The address on the account was O'Brien's.
O'Brien was the registered representative on the account, and one of two
persons authorized to enter transactions for the account. The NASD further
found that the 1983 date on the by-laws should have caused Newman to
question whether the by-laws were current. The NASD faulted Newman for
failing to establish special procedures regarding deposits and withdrawals
of funds from the account or to note that an account established for an
allegedly charitable purpose was engaging in speculative transactions.
We conclude, however, that the record does not demonstrate by a
preponderance of the evidence a failure of supervision by Newman. While
Newman knew that the Scholarship Fund account used O'Brien's address and
telephone numbers, O'Brien denied that he had a beneficial interest in the
account. O'Brien's denial was bolstered by other documents. A certified
copy of a resolution designated O'Brien as an officer of the Scholarship
Fund and authorized him and another person to act on its behalf. In
addition, the by-laws indicated that the Scholarship Fund was to provide
scholarships. Thereafter, the account paid out what appear to
be bona fide scholarship checks. Between September 1992 and April 1993,
each deposit by O'Brien was followed by the issuance of a scholarship
check. O'Brien's sole hot issue violation occurred in April, but O'Brien
did not deposit his funds into the Scholarship Fund account until May.
Thereafter, we agree that he used the account as his own. However, we
cannot say that conduct after the violation serves as a red flag for a
violation that has already occurred. We therefore do not find that the
Firm and Newman failed to supervise O'Brien with respect to O'Brien's
violation of the Interpretation.
IV.
In imposing less than the minimum sanction suggested by the NASD
Guidelines on Zipkin, the NASD noted that Zipkin's violations were
"inadvertent" and that Zipkin had no prior disciplinary history, no
beneficial interest in the CBOE members' accounts, made no effort to
conceal the nature of these accounts, and had not been adequately
O'Brien was the subject of a separate NASD disciplinary
proceeding for this conduct.
While the 1983 date on the by-laws could indicate that
the by-laws were somehow stale, the date on the by-laws
could also be indicative of the long-standing existence
of the Scholarship Fund. The payment of scholarship
checks would appear to verify the fund's purpose.
======END OF PAGE 9======
supervised.
In light of our determination with respect to the Firm and Newman's
supervision of O'Brien, we remand the sanctions to the NASD for further
consideration. We do not intend to suggest any view as to the outcome.
An appropriate order will issue.
By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT,
CAREY, and UNGER).
Jonathan G. Katz
Secretary
The NASD Guidelines (1993) suggest fining an applicant
the amount of any commissions, plus $2,500 to $15,000
for violating the Interpretation, as well as a
suspension in egregious circumstances.
All of the arguments advanced by the parties have been
considered. They are rejected or sustained to the
extent that they are inconsistent or in accord with the
views expressed in this opinion.
UNITED STATES OF AMERICA
before the
SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Rel. No.
Admin. Proc. File No. 3-9192
:
In the Matter of the Applications of :
:
EQUITY SECURITIES TRADING CO., INC. :
2820 IDS Center :
80 South 8th Street :
Minneapolis, MN 55402 :
:
NATHAN NEWMAN :
2110 Austrian Pine Line :
Minnetonka, MN 55305 :
:
and :
:
LAURENCE STUART ZIPKIN :
2801 Westridge Road :
Minnetonka, MN 55305 :
:
For Review of Disciplinary Action Taken by the :
:
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. :
:
ORDER SUSTAINING IN PART AND REVERSING IN PART DISCIPLINARY ACTION TAKEN BY
REGISTERED SECURITIES ASSOCIATION
On the basis of the Commission's opinion issued this day, it is
ORDERED that the findings of violation made and sanctions imposed by
the National Association of Securities Dealers, Inc. against Laurence
Stuart Zipkin, and the Association's assessment of costs, be, and they
hereby are, sustained; and it is
FURTHER ORDERED that the findings of the Association that Equity
Securities Trading Co., Inc. and Nathan Newman failed to supervise Laurence
Stuart Zipkin be, and they hereby are, sustained; and it is
FURTHER ORDERED that the findings of the Association that Equity
Securities Trading Co., Inc. and Nathan Newman failed to supervise Michael
J. O'Brien be, and they hereby are, reversed; and it is
FURTHER ORDERED that the sanctions imposed by the Association on
Equity Securities Trading Co., Inc. and Nathan Newman, and the
Association's assessment of costs, be, and they hereby are, remanded to the
Association.
By the Commission.
Jonathan G. Katz
Secretary